FMA/RBNZ Life Insurer Conduct and Culture Report

Following our regulatory update in our October 2018 edition of Cover to Cover, we provide a brief update on the latest regulatory developments affecting the insurance sector.

Life Insurers given 30 June deadline to address regulator feedback

The Financial Markets Authority and the Reserve Bank of New Zealand released their Life Insurer Conduct and Culture Report on 29 January 2019 (Life Insurer Report)1. The Life Insurer Report sets out findings from the regulators’ review of the conduct and culture of sixteen New Zealand life insurers and represents the second phase in their review of the financial services industry.

As widely predicted, the Life Insurer Report is much more critical of the life insurance sector than the regulators’ November 2018 Report on the Banking Sector (Banking Report). The Life Insurer Report found “extensive weaknesses in life insurers’ systems and controls” 2, including weak governance and management of conduct risks and a lack of focus on good customer outcomes. The regulators also make it clear that, while life insurers were prioritised for the review, “all insurance sectors should be actively considering conduct risk within their business”.

Although the regulators conclude that they would not currently categorise instances of poor conduct and potential misconduct as widespread (and issues similar to those highlighted in the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (ARC) are considered to be on a “much smaller scale”), in line with the extent of the issues identified, the regulators have set out explicit guidance on the matters they expect life insurers to address. There is a clear expectation that life insurers will consider and act on all relevant recommendations made in the Life Insurer Report.

Key findings in the Life Insurance Report

The Life Insurer Report makes the following key findings:

Insufficient systems, controls and policies

There are “extensive” weaknesses in life insurers’ systems and controls.

There was a lack of analysis of the systems, processes and controls in place against the matters highlighted by the ARC and related investigations. Insurers’ confidence that the issues identified by the ARC would not occur here is “misplaced”.

While most insurers had a whistleblower policy, these did not always provide an anonymous, confidential and independent channel for raising concerns. The policies were not always well-known and were infrequently used (although the regulators noted that staff across most insurers indicated that they would be comfortable raising an issue).

Conduct risk

Life insurers have been complacent in addressing conduct risk, too slow to implement changes following FMA reviews and insufficiently focussed on developing a culture to balance shareholders’ and customers’ interests.

There were instances of poor conduct and potential misconduct (albeit these were relatively few). However, there is a serious risk of further conduct issues arising in the future. The regulators saw evidence of insurers’ sales incentives structures creating risks that sales would be prioritised over customer outcomes.

Reporting on conduct risk was limited and often focussed on ‘lag’ indicators such as complaints. Conduct risk management was insufficiently integrated and risk management functions were frequently resourced too thinly. The processes and systems for customer complaints and incident management were generally under-resourced and inconsistently used. The regulators observed that they cannot be confident that life insurers are aware of all current issues.

Remediation of conduct issues has been poor with insurers’ responses being slow or insufficient (with insufficient systems to monitor and manage remediation). In some extreme cases there was a complete lack of interest in remediation at all.

Until the review, few life insurers had seriously considered conduct and culture issues. Boards and senior management were not setting the tone to manage these issues and prioritise good customer outcomes. The Report expressed some concern that the boards of insurers which were part of a bank or a foreign-owned insurer were not sufficiently independent.

Product design and training

The Regulators saw limited evidence of products being designed (and sold) with good customer outcomes in mind, as well as a varied approach to ongoing contact to monitor the continued suitability of products. There were limited policies to deal with potentially vulnerable customers.

Training on products, sales, and advice was generally under-resourced and under-prioritised. In particular, training for intermediaries was inadequate and there was little evidence of training on conduct expectations.

Intermediaries

In situations where sales and advice were provided through an intermediary, the regulators found a lack of oversight and responsibility for the sales, advice, and customer outcomes.

As provided above, training for intermediaries was considered inadequate and there was little evidence of training on conduct expectations.

The regulators observed that “consumer trust is paramount to the effective functioning of the life insurance industry in New Zealand. We are concerned that this trust could be eroded unless life insurers – led by boards and senior management – transform the way they approach conduct risks and issues, and achieve a customer-focused culture.” 3

Recommendations for Insurers

In line with the extent of the issues identified by the Report (for which an overview is provided above), the regulators have been more prescriptive in their requirements of the sector, providing clear direction on the matters that need to be addressed and by when (30 June 2019). The Life Insurer Report identifies a number of areas for life insurers to make substantial improvement in order to identify, manage, remediate and report on conduct and risk issues and to deliver consistently good customer outcomes, including:

The role of Boards

Boards need to take responsibility for setting the tone from the top, with a focus on good customer outcomes, by having a clear plan for change that sets targets, assigns responsibility, includes milestones and ensures information flows to all parts of the organisations.

Oversight of intermediaries

Insurers need greater oversight of how intermediaries are selling and managing their products. Both insurers and intermediaries need to be responsible for ensuring good customer outcomes, but the insurer remains ultimately responsible for this.

Product design, training and support

New products should be designed to provide good customer outcomes. Target markets and intended outcomes for products need to be clearly identified.

Staff need to receive ongoing comprehensive training on the products they sell and support.

Insurers need to proactively and regularly communicate with their customers and encourage customers to consider whether their needs have changed and whether the product remains suitable for them.

Policies and processes

Risk management processes need to be appropriate and incorporate all material risks, including the monitoring and management of conduct risk, and the review of advice provided at point of sale and over time.

Insurers must have a relevant code of conduct, educate staff on good conduct, and have clear policies, processes and training for identifying and dealing with vulnerable customers.

Insurers need to have an accessible, confidential and independent whistleblower process.

Identification and remediation of issues

Insurers need appropriate and sufficiently resourced systems and processes to record and resolve customer complaints and incidents and to proactively identify and resolve issues.

Incentives

Insurers are expected to remove or substantially revise incentives linked to sales for sales staff and all layers of management no later than the first performance year after 31 December 2019, and, if not removed, to be able to explain to the regulators by 30 June 2019 how control systems will be strengthened to mitigate conflicts of interest and risk to customers.

Insurers are also expected to review commission structures for intermediaries and change their qualifying criteria for soft commissions to ensure they are incentivising the delivery of good customer outcomes.

Recommendations to Government

The Life Insurer Report also makes a number of recommendations to Government for strengthening the regulatory framework governing conduct in the life insurance sector (and by implication, the general insurance sector as well).

The Life Insurer Report notes (among other things) that:

While the review has not identified any notable regulatory gaps from a prudential perspective, there would be benefit in progressing some of the enhancements being considered under the Insurance (Prudential Supervision) Act 2010 (IPSA) review.

The RBNZ, the FMA and the Commerce Commission each regulate parts of the wider insurance industry, but no regulator has oversight of insurers’ and intermediaries’ conduct over the entire insurance policy lifecycle.

Given the similarities in the nature of the regulatory gaps identified as part of the Banking Report, the drivers of risk and the benefits of having consistent frameworks across regulated industries, these areas may be equally relevant to life insurance. The regulators suggest that the Government consider:

establishing basic duties on life insurers to protect and enhance customer interests and outcomes (regardless of the distribution channel)

requiring life insurers to have adequate systems and controls to govern, manage conduct risk, and remediate issues, in all distribution channels, and through the life insurance product lifecycle

reviewing whether the regulators have sufficient supervision and enforcement powers and resources to ensure life insurers meet these obligations, including requiring better information on conduct issues or risks, and the option of penalties to incentivise appropriate behaviour

clarifying accountability and individual responsibility for management of misconduct, including the potential for direct liability for senior managers

Government Response

Immediately after the Life Insurer Report was released, the Ministers of Finance, Commerce and Consumer Affairs advised that the Government will fast-track legislation to address the consumer protection issues highlighted in the Life Insurer Report.4

The proposed changes will promote:

clearer duties on banks and insurers to consider a customer’s interests and outcomes, and to treat customers fairly

an appropriately resourced regulator to monitor the conduct of banks and insurance companies, with strong penalties for breaching duties

changes to both banking and insurance regulation, as the issues identified in both are similar. There are also overlaps between the sectors, with banks also selling insurance products

a strong response to internal sales incentives and soft commissions

While the scope of the legislative changes has not been explained in detail, Cabinet has specifically agreed “to get rid of sales incentives in the insurance industry that are driving behaviour that is not in the best interest of consumers”. A consultation paper will be released in May and legislation will be introduced later this year. This will run parallel to the review of insurance contract law, with the intention that both bills will be in Parliament by mid-2020.

Our view

The regulation of the insurance sector (both life and health, and general) has been under intense scrutiny over the past two years. This follows the IMF/World Bank releasing the 2017 regulatory assessment of New Zealand’s financial system, which identified a number of gaps in our regulatory framework, including a lack of conduct regulation of the insurance industry.

In addition, through several thematic reviews and discussion documents, the FMA has been critical of the heavy reliance by some life and health insurers on commission-based sales structures and the potential harm that these can cause to customers. The FMA has signalled the need for the sector to make significant changes to the way in which insurance products are marketed and sold, through to the way in which claims are managed, requiring a more customer-centric approach than exists currently.

What is already being done?

Many insurers are already moving to address some of these concerns. A number of life insurers last year voluntarily abolished the use of soft commissions following the findings of the FMA in its May 2018 report on conflicted remuneration in the life insurance industry. In addition, the Financial Services Council (whose members include 95% of the life insurance market in New Zealand) introduced a new code of conduct (Code) for its members on 1 January this year. The Code covers ethical, communication and consumer outcomes which are designed to complement existing regulation and laws. A breach of the Code can result in fines of up to $100,000 or termination of membership.

However, despite these initiatives, the regulators have continued to be vocal in their concern about their findings of conflicted conduct in the life insurance sector and inadequate attention paid to customer needs identified in the various thematic reviews. It therefore must come as no surprise that the Life Insurer Report is critical that more and faster change in the sector has not yet occurred, and that the requirements for change in the sector are more prescriptive than those in the Banking Report.

Regulatory gaps

The themes emerging from the Life Insurer Report will likely be reflected in important policy decisions in connection with the review of insurance contract law and conduct currently being undertaken by MBIE, and the review of IPSA being undertaken by RBNZ.

This has already been confirmed by the announcement that the Government will fast-track legislation to address the issues identified in the Life Insurer Report (and the Banking Report that preceded it), including a ban on conflicted sales incentives.

This demonstrates the importance placed by Government on ensuring that consumer interests are adequately protected by regulation both in the wider insurance and banking sectors.

The RBNZ has also indicated that it will be discussing its newly established Relationship Charter for working effectively with banks with insurers in the first quarter of 2019. The Relationship Charter “commits the Bank and the financial sector to a mutual understanding of appropriate conduct and culture”.5 Along with the underlying principle of the Charter (expressed by RBNZ Governor Adrian Orr as the principle “‘te hunga tiaki’, the combined stewardship of an efficient system for the benefit of all”), this may suggest that the RBNZ is keen to work with the insurance sector to ensure a mutual understanding of appropriate conduct and culture across the financial services industry.

In the meantime, the imminent changes to financial advice regulation (to be introduced by the Financial Services Legislation Amendment Bill) will go some way to address the Regulators’ concerns around the mis-selling of insurance products and insurance churn, but will not be sufficient to address the deeper concerns expressed around insurer responsibility for good customer outcomes.

The regulators’ deadline of 30 June for life insurers to report on the measures taken and plans in place to remediate the poor conduct they have observed during their review, and the promise of Government-led regulation to enforce changes to the incentives-based sales structure of the insurance industry, will serve as an immediate incentive to insurers to make those changes ahead of the regulatory imperative to do so.

What next?

The regulators will be providing specific findings to all 16 life insurers by the end of February 2019 and will require them to report back and provide an action plan to address the feedback by 30 June 2019 (including how they will address incentives based on sales volumes for internal staff and commissions for intermediaries).

The insurers will also be required (among other things) to undertake a gap analysis against the ARC Report findings (released on 4 February 2019) against their own business structures and processes. The ARC Report is discussed in a separate article in this issue of Cover to Cover, and sets out a summary of the findings of the ARC in relation to insurance misconduct in Australia (an aspect not covered in the previous ARC Interim Report).

Conclusion

Although the Life Insurer Report focuses on life insurers, all participants in the insurance industry need to read the Life Insurer Report. The Regulators note that non-life insurers are also expected to assess their conduct and culture frameworks against the findings in the Life Insurer Report and consider and act on all relevant recommendations made by the Regulators.

The Boards and senior management of life insurers will also need to digest the Life Insurer Report’s contents quickly, so that its key messages can be disseminated appropriately and any operational and cultural changes required to address the regulators’ concerns are able to be put in place and reported on by the deadline of 30 June 2019.